Offshore oil drillers find confusion over worst-case spill

When the Obama administration lifted the deepwater oil and gas drilling moratorium Tuesday, the response from industry leaders and Louisiana politicians was remarkably tepid, owing mainly to fears that bureaucratic obstacles to drilling will remain even though an outright ban no longer exists.

The skeptics based their concerns on the experience of smaller, independent oil and gas operators in the shallow-water Gulf of Mexico. Those operators faced no official ban but decried what they called a de facto moratorium. After an initial stoppage in May after the deadly explosion of the Deepwater Horizon rig, the government issued new safety requirements for shallow-water operators.

Over the next four months, only six permits were granted. Typically, perhaps 40 permits would have been issued during that span.

The main reason for the slowdown, according to shallow-water operators, was not the difficulty in complying with new safety measures on the rigs. Rather, it was confusion over the worst-case discharge of oil from below the ocean and the insurance some of them were required to carry as a result.

Jim Noe, executive director of the Shallow Water Energy Security Coalition, said his members quickly got their blowout preventers inspected and certified, signed statements attesting to safe operations and submitted clear well design plans, all in compliance with government regulations. But the new rules for estimating a worst-case discharge in case of a blowout tripped them up.

Apparently, it also confused regulators at the Interior Department's Bureau of Ocean Energy Management, Regulation and Enforcement.

"There has never been a moratorium on shallow-water drilling, de facto or otherwise, " the bureau's director, Michael Bromwich, said while meeting with reporters this week at the Platts Energy Podium in Washington. "There were some issues that had to be clarified, particularly with the requirement to come up with worst-case discharges. Companies were having a difficult time doing the analysis, and the truth is some of our people originally weren't completely sure of how to handle that kind of analysis."

Bromwich contended the confusion is dissipating because he reallocated regulators to handle the shallow-water permits. He said the number of shallow-water permits issued doubled from six to 12 in the past two weeks.

Still, the mostly smaller, independent firms that operate in shallow-water "shelf" prospects aren't sure the logjam has broken. Before the BP Macondo well blowout April 20, they were getting between 10 and 12 permits to drill new wells every month. Even permits for repair and sidetracking work on existing wells have slowed.

The sticking point remains the discharge figures and the commensurate insurance policies smaller operators must carry, by federal law. After drilling 40,000 wells on the shelf, shallow-water operators say, they have a much better idea of how bad a spill could get than do their peers working the less-known reservoirs in deepwater. But they say the new rules are too conservative when it comes to worst-case scenarios.

For example, one permit for a thoroughly explored shallow oil field got bounced back to the operator for months as regulators contended that the worst-case discharge would be 10 times larger than the figure the oil company estimated. On an oil field that historically produced 1,500 barrels a day, the operator applied for a permit by assuming a worst-case discharge of 2,500 barrels a day. Regulators said it should have been 25,000 barrels a day.

On top of that, federal regulations require companies to cover the costs of four times the worst-case discharge, or, in the case of this example, 100,000 barrels a day. That volume would be nearly twice as much as what came out of the clearly larger deepwater Macondo well.

The big difficulty for shallow-water drillers is to find insurance coverage for that level of discharge. By law, they must be able to pay $35 million for up to 35,000 barrels of oil spilled each day, and another $35 million for each 35,000-barrel-a-day increment -- all the way up to $150 million for anything over 105,000 barrels a day.

Companies can't self-insure if the amount they must pay exceeds 10 percent of their net worth. A worst-case spill of 100,000 barrels a day would require a company to be able to pay $105 million. That's more than the annual total investment of some major shallow-water players. To self-insure for that would require a net worth of $1.1 billion, which is beyond the capacity of most shallow-water operators. That means they must purchase a $105 million spill insurance policy, which carries an annual premium of about $625,000, based on recent industry analyses.

Premiums are 25 percent higher in the shallow water since the Deepwater Horizon spill and have gone up by as much as 50 percent in the deep water. The greater uncertainty of the size of oil reservoirs under more than 1,000 feet of water could lead to even more debate with regulators over worst-case discharge.

Asked about this possibility, Interior Department spokeswoman Kendra Barkoff said: "We need to be assured that risks of deepwater drilling have been minimized. The additional requirements will present challenges that will have to be overcome in the beginning of the process."

There is good news for the deepwater operators, however. Debbs Nelson, general manager of Texas-based Arena Offshore, said his deepwater brethren still have the financial capacity to self-insure in most cases and have had a chance to observe and learn from shallow-water companies' recent regulatory struggles.

"If you think that just because the moratorium is lifted all these rigs will go to work, think again, " he said. "But I think (deepwater operators) will be advantaged because we've gone through these learnings on the shelf. Hopefully, through the struggling we've gone through, they'll be able to move more quickly."